Who do hedge funds have to thank for being able to keep 20 per cent of all the profits they make for investors?

The Phoenicians, of course. According to Sebastian Mallaby’s history of hedge funds, More Money Than God, the world’s first recognised hedge fund manager, Alfred Winslow Jones, adopted the profit share arrangement of these ancient traders whereby they got to keep one-fifth of all the riches they gathered.

The famed 2 and 20 model in which investors pay a 2 per cent management fee and retain one-fifth of all the excess profits has become entrenched as an industry standard.

Winslow Jones was born in Australia, so it’s ironic that local funds are leading the push-back on the fees charged by hedge fund managers.

Fees are said to always be the first topic of discussion when Australian funds engage with hedge funds while it’s always the last one asked by international funds.

While fees had arbitrary beginnings, an environment in which returns are harder to come by has led managers to scrutinise how they are charged. But coming up with a good way to determine exactly how much an investor should pay is not simple, as
Adrian Redlich
, one of Australia’s top hedge fund managers at Merricks Capital, pointed out at this week’s Alternative Investment Manager’s Association conference in Sydney.

“The way of the future has to be to pay managers per unit of alpha they generate … alpha being the return that is not explained, or not correlated, by the market going up or down," he told The Australian Financial Review.

“Alpha is hard to define but that is the job of a good asset allocator or consultant," he said.

Related Quotes

Company Profile

Cause for contention

Blackstone Alternative Asset Management’s
Scott Soussa
said the ability of hedge funds to cling on to their high fees while other traditional managers were being forced to cede theirs, was a cause for contention and press coverage.

“Alternatives is the area that has maintained fees for the most part, while there has been fee compression in other asset classes. But from our standpoint we evaluate everything on risk-adjusted returns and net returns."

The Blackstone Group is the largest allocator to hedge funds in the world with $53 billion deployed. Soussa said there was a greater emphasis on the costs in running a fund when determining fees.

“People are starting to evaluate fees on the basis of cost to run a business whereas years ago, the 2/20 was just 2/20 because, it was 2/20, with no analysis done [on the justification]."

Yet many investors don’t believe the cost of running a fund should come out of their pocket, but should be borne by the owners of the hedge fund. And they might argue that some complex and expensive hedge fund strategies do not guarantee that “alpha" will ultimately be generated.

Manager fees is not a debate that is going away. But ultimately, they’ll be determined by the same market forces hedge funds try to outwit. Even the best managers should sleep a little uneasy knowing that if they’re not delivering – those lucrative fees will be consigned to history.